The Hindu Business Line : Fed moves close to rate cut

Post-payroll, the question is not whether but when the Fed will cut interest rates. Its next meeting is only a week away. Expect rates to be slashed even 50 bps.

S. Balakrishnan

If the US Federal Reserve’s Federal Open Market Committee (FOMC) – which sets American interest rates – needed an excuse to cut its cost of funds benchmark, it got that in spades last Friday, when data showed the economy lost 4000 (non-farm) jobs in August.

To add insult to injury, the estimates of job additions in the previous two months were adjusted significantly downwards.

The figures overshadowed the Fed’s ‘Beige Book’ (survey of countrywide business conditions), which found that, except for housing, economic activity, though not robust, continued at modest levels.

Post-payroll, the question is not whether but when the Fed will cut interest rates. Its next meeting is only a week away. Expect rates to be slashed even 50 bps.

No such luck is in store for Indian business. Despite another drop in the WPI to 3.79 per cent in the latest week, the Reserve Bank of India is unlikely to lower its inflation guard.

Pit falls

For one thing, liquidity is too comfortable for the central bank’s comfort. (Reverse repos are seeing tenders of around Rs 40,000 cr.). Free government spending will more than neutralise the effect of advance tax collections, keeping the economy in stimulus mode.

The pitfalls are easy to spot. Depending as we do on portfolio inflows for market buoyancy, a negative fallout from risk aversion among foreign investors, given their ‘home’ crisis, is possible, in which case our economic wheel could slow too.

The biggest problem facing the Fed, European Central Bank (ECB) and Bank of England (BoE) is the breakdown of confidence in the inter-bank market.

Three month LIBOR – the market benchmark – is at seven year highs and the spread between LIBOR and T-bills is as much as 1.5 per cent. The CP market is also in crisis with few takers for mortgage-backed CP issues.

Trust deficit

In short, inter-bank financing is shrinking, forcing central banks to ease liquidity and collateral requirements. Banks are unable to offload bridge loans for corporate takeovers.

There are liquidity and interest rate mismatches galore. Rate cuts may be a way out for the economy, but are they the solution to the ‘trust deficit’ in financial markets and institutions?

Oil shock

In other news, oil at $ 76+ is back near its all-time highs on falls in US crude and gas inventories and hurricane fears.

Sooner or later India must react and that could call ‘finis’ to the current trend of declining inflation. Still, a prospective US and global slowdown is a big bear factor for oil.

Both the European Central Bank (ECB) and Bank of England (BoE) held rates and will not act till liquidity and growth risks are out of the equation.

China increased its CRR equivalent to 12.5 per cent from 12 per cent. Its forex reserves are a record $1.4 trillion. However, its exports could hurt from safety and health issues.

The current week has key US data- trade balance, current account, retail sales and consumer confidence.

Data will be overall negative, buttressing the necessity for early Fed action.

More Stories on : Interest Rates | Financial Scan

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Rupee gains 10 paise

Kotak Life plans more branches

Banks need to tone up risk management

‘FCCB issuances this year slowing down’

Brand premium for PSU banks

IFCI continues upward march

Fed moves close to rate cut

Bond prices decline

GoM will discuss issue of bonds to fert sector

Bank loan growth hits lean patch

Indian Bank keen on micro-credit

Call ends at 6.05-6.15%

Co-branded credit card for SMEs

OBC raises FCNR rates